As we mentioned earlier this week on The Call, we visited with Corporate Office Properties Trust (OFC) and toured some of their assets ahead of developing a more fulsome view post-UHAL/COLD in September. One of the challenges with covering office REITs is the "commodity-like" nature at the asset level, i.e. there is not much difference quality-wise between and among the portfolios of PGRE/SLG/VNO for example. The differences show up primarily at the corporate, management and capital structure levels, so making individual stock calls is relatively hard and almost futile, in lieu of making a submarket bet on Manhattan with either a basket or the largest, most well-capitalized name. What we are going to try to do is focus on scarcity and non-commodity office in making long (particularly) and short calls. OFC is an obvious candidate to have on that list, as we view OFC as more irreplaceable critical infrastructure versus office. For this reason OFC at times flies under the radar but we believe deserves more attention.
By way of background, OFC has carved out a niche business for itself in owning, developing, and operating office assets leased to government tenants (nearly ~35% of ABR) within the mission critical Defense/IT establishment, as well as contractors and cloud service providers that serve a similar mission. Combined Defense/IT between the public and private sectors account for ~85% of total GAAP/straight-line NOI. The Fort Meade/BW corridor in Maryland + NoVa defense/IT segments account for over 55% of NOI, with the now smaller regional office portfolio accounting for only ~10% of NOI and essentially serving as a strategic source of funds when conditions are right for capital recycling. The company also has a data center business sitting within that aggregate Defense/IT figure, which represents higher-yielding development but also an attractive source of equity capital through JVs once stabilized.
OFC is indeed "defensive" and probably among the most "bond-like" of office REITs, with a high-quality tenant credit profile and above-average dividend yield. For these reasons the stock will be very interesting if and when we enter a Quad 4 environment, so we are doing the in-depth work out ahead of that. Finally, several years of trimming non-core assets resulted in a "hampster wheel" effect where annual Core FFO hovered around $2/share. The math indicates that 2021 could be the beginning of an earnings inflection point. Full disclosure - OFC would likely not work well relatively speaking in Quads 2/3, as there is less pricing power/operating leverage intrinsic to the business model versus the shorter-duration lease sectors. More to come...
Figure 1: OFC GIP Backtest
Figure 2: Hedgeye REITs Position Monitor
Please call or e-mail with any questions.
Rob Simone, CFA
Managing Director
Twitter: @HedgeyeREITs
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